Not Out of the Woods

NOTE: This article has been modified to serve as a complement to the now published full length article (http://ezinearticles.com/?The-...). It provides the charts and table publishers could not publish.

That is right. If you thought the worst was over and you could return to business as usual with the stock market, think again. The spike in volatility alone should signal there has been a paradigm change. Regardless which popular metric you use; PE, Shiller’s CAPE Ratio, or Buffett’s Market to GDP comparison; this is still one of the most expensive markets of the past century. The other two were the 1929 and 2000 markets and we know how those turned out. And we still have a demographic scenario[1] that warrants a major market drop.

The question is when. Some folks are under the mistaken impression that stock market crashes occur at market tops. That is far from the truth. A study of major bear markets, those declining 28-plus –percent, since 1923, the year the precursor to the S&P 500 was introduced, reveals there is always a preamble to every major bear market. This is shown in the analysis below for each of the following major bear markets (28% decline or more): 2007, 2000, 1987, 1973, 1968, 1962, 1946, 1937, and 1929. Intraday prices and daily closes are only available for the S&P 500 from 1950 on. Therefore, Dow Jones Industrial Average closes were used for the markets before that.

2007

The initial top for the 2007 market came July 17 when the S&P 500 had an intraday high of 1555.90. After dropping 11.9% the market would climb again to a market top for the index of 1576,09 October 11, 2007 - 1.3% higher than its previous high. It would then drop to 666.79 March 9, 2009 for a 57.7% decline.

2000

The market climaxed at 1552.87 March 24, 2000 for the S%P 500. It would drop precipitously April 14 to a low of 1339.40 – a 13.7% drop – but then slowly recovered to 1530.09 by September 1, 2000, only 1.5% below its all-time high. The market bottomed at 775.80 October 9, 2002 for a 50.1% decline.

1987

After hitting a high of 337.89 August 25, 1987, the S&P 500 dropped to 308.58 by September 8 – an 8.7% hit. It quickly recovered to 328.94 by October 2, only 2.6% down from its high. The low point came October 20, when it dipped to 216.46 for a loss of 36.0% from the August high.

1973

This, along with the 1968 bear market, were part of the mega bear market that spanned 1967 – 1982. The S&P 500 peaked at 119.79 December 12, 1972 and then dropped 4.3% to 114.63 December 21, 1972. The index reached a top of 121.74 January 11, 1973 - a 1.6% gain from the previous high. It hit bottom at 60.96 October 4, 1974 – a 49.9% loss.

1968

The S&P 500 topped December 2, 1968 when it maxed out at 109.37. The index dropped to 96.63 by January 13, 1969 (an 11.6% drop) and then rallied all the way up to 106.74 May 14, 1969 coming within 2.4% of the top. It hit bottom May 26, 1970 at 68.61 for a 37.3% haircut.

1962

The S&P 500 topped out at 72.64 December 12, 1962. Then it dipped to 67.55 January 24, 1963 for a 7.0% loss. The index peaked at 71.44 March 15, 1.7% below the high. Thereafter, the index plunged to 51.35 June 25, 1962 for a 29.3% decline.

1946

The Dow Jones closed at 206.61 February 5, 1946. The index then plunged 10% to close at 186.02 February 26. It quickly recovered riding up to a 212.5 high May 29, 1946 – a 2.9% gain from its previous high. The market would continue to struggle until February 1948 with a maximum loss of 28%.

1937

The Dow Jones closed at 194.4 March 10, 1937 to mark the end of a three-year uptrend. The index bottomed June 14, 1937 at 165.51 for a 14.9% loss. It spent the next two months on a steady climb eventually topping at 189.34 August 16, 2.6% below the previous high. Thereafter, the market plunged 49.1% to its 98.95 March 31, 1938 Dow Jones close. (Chart Link: http://blog.afraidtotrade.com/resolution-of-the-1937-dow-bear-market/).

Historical data shows that every major bear market since 1923 always provided investors with a warning. After initially peaking, there was a surprise drop followed by a recovery to a new peak. Declines after the initial peak ranged from 14.9% to 4.3% with an average of 10.0% and a median also of 10.0%. Except for two cases, 1973 and 1946, the second peak was lower than the first. The range was from a loss of 7.4% to a gain of 2.9% with an average and median of -1.7%. Taking out the 1929, 7.4% outlier, the average was -0.98% and the median -1.6%. The time between the two peaks ranged from 20 days to 5.4 months with an average of 89 days and a median of 93 days.

Assuming we are in the beginning stages of a major bear market, and having gone through a 10% correction we are in the same spot the 2007, 2000, 1968, 1946, 1937, and 1929 markets were in. Do not dismiss the magnitude of the decline. While officially it was barely a correction, a 10.2% drop, this only takes into account closing values. When measured from intraday high to intraday low, as the market study above, the decline was more bearish - 11.2% from the 2872.87 high of January 26 to the intraday low February 9. Although there was no consistent pattern for depth of the initial decline and the total decline, it is notable that the four largest initial drops led to declines of 49% or more – a level only achieved by the 1973 bear market after only a 4.3% decline. While, there seemed to be no relationship between the severity of the bear market and the time lapse between the two peaks, five out of the six times the market went through a bonafide correction it took months, between 3.4 and 5.2 months, for the market to top and begin its downturn in earnest. The notable exception was the Crash of 1929, which only took 37 days between the first and seconds peaks. Other than that, there was no discernible relationship between the initial and total declines, the initial decline and second peak level, nor the total decline and second peak level.

We have already gone above the -7.4% level from 1929, so it would seem this market does not correlate all that well to that one and the wait to the next decisive peak will be measured in months. Using the range for the other correction markets as a guide, that would indicate the fall would come somewhere between April 20 and July 7. Moreover, odds are the second peak will not reach the heights of the first and come within -2.6% and -1.5% of the January 26 market top. Therefore, take cover once the S&P 500 reaches 2798

(-2.6%). That is your signal to exit the stock market. Thereafter, be greedy at your own peril.

[1] See: Karl De Jesus, It's Deja Vu All Over Again - Wanted: More Old Timers at the Money Helm, March 23, 2018, Ezine Articles, (http://ezinearticles.com/?Its-...).

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As I read it, you've shown that every bear market has been preceded by an initial dip/correction, but you haven't told us whether every dip/correction immediately precedes a bear market, and if not what is the probability of a bear market in some time span following a correction. Without that, it's hard to draw any conclusion from your post to the current market, other than that current high valuations and the recent correction provide the historically requisite conditions for a bear market to start.

Until recently I was totally out of the market in retirement accounts I could not short. Otherwise, I was short. After Monday's drop, I decided to put my money where my research was. Given that it indicated the market would rise until at least 2.5% of the January 26 high, I went all in on the S&P 500 either in ETF's or funds. I do not recommend it for the weak at heart and I am a bit nervous myself. Nevertheless, I hope to make an 8 - 9% return and then get out...for good.

You are correct on both accounts. My previous research indicated that we were on the verge of a major downturn. As a result, I began with the premise a major bear market was in the works. The study is, therefore, focused on only major bear markets and not bear markets in general. I do not know at this time if all bear markets are preceded by a drop, but I know major bear markets are. Given the numerous drops and corrections, it is likely that the percentage preceding bear markets would be too low to be actionable, although it would be an interesting study.

The issue to factor in is that USD hegemony is ending to be replaced by nothing (Renminbi not able and ready). With that exorbitant privilege over the US must convince the world that it’s paper’s good. That’s a tough gig. So the USD is in a structural downtrend. It’s a balance of payments crisis but with unusual characteristics relative to the classic (like Argentina). The USD will remain transactionally supreme throughout as the unit of account but just not the denomination of value.

What does that mean? It’s just not the same game. Old pattern are a bit bogus. It’s possible that equity markets remain expensive in US and get more so. For example, if you’re China you can’t sell all that US debt paper for, say, Brazilian. So perhaps swap it out for dollar denominated real assets.